In February, the markets took a turn for the worse as the S&P 500 started to follow an eerily familiar pattern.
During that month, the S&P 500 saw its 10-month moving average cross below its 20-month moving average, something that hasn’t happened since (drumroll please) … 2008.
That’s right, the slow, tectonic shift in the S&P 500’s long-term technical trends is suggesting that stocks are mimicking the activity we saw as the market headed into a bear market that would strip 50% of the S&P 500’s value from it over a nine month period.
Making matters worse is the fact that before 2008, the previous occurrence of this bearish chart pattern was in February 2001, ahead of a 40%-plus decline in the S&P 500.
Interestingly, many on The Street are talking about how today’s market isn’t a 2008 situation and that things are different this time around. Well, to that you have to answer that 2008 wasn’t the same as 2001, or any other bear market in the past. The point is, all bear markets don’t look the same but they do have certain traits and patterns that serve as warning signs.
Similar to the 2008 charts, the S&P 500 recently experienced a 12% rally from its February lows, right up to the potential resistance of its long-term trendlines. This matches to a “T” the pattern that we saw in 2008 (highlighted in red in the charts above), which should serve as warning, especially with earnings season right around the corner.
Like any other valuable asset, investors should be interested in protecting their portfolios against declines in value. We protect our houses and cars with insurance … why not our portfolios?
Of course, nothing can completely insure your portfolio, but there are a number of attractive and easy investments that allow you to “hedge” your portfolio against the market’s downside risks and volatility like a pro. The following are a few of our favorite Plunge Protection exchange-traded funds.
ETFs to Buy to Protect Your Portfolio: Proshares Short S&P 500 (SH)
Trading since June of 2006, the Proshares Short S&P 500 ETF (SH) is one of the original hedging ETFs. The fund is invested in such a way that it provides a one-to-one hedge against moves in the S&P 500.
In other words, the SH shares appreciate one percent for every one percent decline in the S&P 500 Index.
The recent rally in the S&P 500 has seen the Proshares Short S&P 500 shares decline to the $20 level, a relative low and site of technical support. For now, we see this as a “bottom” for the shares and an opportunity to utilize the ETF as a hedge in your portfolio.
How to use it? Let’s say that you want to “hedge” 25% of your portfolio instead of sitting in cash. Simply allocate that dollar amount to purchase the SH shares. If there was then a 10% decline in the S&P 500, the hedge would offset that drop in the rest of your portfolio by a total of 2.5%, assuming your portfolio moves in tandem with the market.
In other words, an unhedged portfolio could be down 10%, but yours could only be down 7.5%.
Expenses are 0.9%, or $90 per $10,000 invested.
ETFs to Buy to Hedge Your Portfolio: ProShares UltraShort Small Cap 600 ETF (SDD)
Small-cap stocks have lagged the market for more than a year, suggesting that the “risk on” trade remains “off”. Unfortunately, the market climb higher only when investors are willing to be speculative — not when they play it safe, as they are right now.
Given this, those investors who would like to get a little more aggressive with their hedge should consider ProShares UltraShort Small Cap 600 ETF (SDD). The SDD shares allow investors to short the Small Cap index with some leverage. The fund seeks to return twice the inverse of the S&P 600 Index, meaning that a 1% decline in small caps would return something close to 2% to the SDD shares.
Currently trading at $33.95, the SDD shares are well off of their February highs of $48.10 (29% for those wondering). This hedge is much more speculative than using an unleveraged inverse ETF, so it’s not for all investors. Expenses are 0.95%.
ETFs to Buy to Hedge Your Portfolio: iPath S&P 500 VIX Short Term Futures ETN (VXX)
Another of our favorite hedges is the “volatility hedge” using the iPath S&P 500 VIX Short Term Futures ETN (VXX). The CBOE Volatility Index (VIX) is known as the “fear gauge,” as it moves higher as investor sentiment turns more fearful. Given this, the VXX shares allow investors to profit from increases in volatility as it moves at a one-to-one ratio with the VIX.
The VIX is coming off of its lowest readings since November 2015, just after the S&P 500 hit its highs after a Dead Cat Bounce rally. Trading at $17.62, the VXX shares are trading about 43% off of their February and November highs, indicating significant upside potential.
With the S&P 500 looking to continue to trade in bear market territory, the VXX shares appear to have some significant upside potential as a hedge for your portfolio. Expenses are 0.89%.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.